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What The Rig Plunge Really Means For The Price Of Oil
Arguably the biggest catalyst for the surge in crude, in addition to the technical move which started off with a vicious short squeeze into the NYMEX close last Friday, was last week's record drop in the Baker Hughes rig count to 1,223, down from 1,609 just three months earlier. That, coupled with the ever louder reports of majors and all other energy companies cutting CapEx, has led some to believe that the supply imbalance is finally starting to normalize, and that production in the coming months will sharply drop off. However, as Morgan Stanley's Adam Longson explains, that is not nearly the case.
Here are his big picture thoughts on what the recent rig count drop relaly means:
The devil is in the details: The market is likely too excited about falling rig counts. Even after the natural gas experience, the market fails to appreciate that the relationship between rig count and production can be deceptive. Headline rig count declines may look impressive, but as we look at the data, much of the drop in oil rig count has come in low yielding vertical/directional rigs – i.e. the low-hanging fruit. Even within horizontal rigs, much of the decline has come in lower performing plays or lower tier counties within high quality plays. In some cases, we’ve seen a reallocation of rigs between counties within plays. This was particularly prominent in Midland last week. The most productive rigs will likely remain as long as possible, esp where hedges are in place, until redeterminations or cash flow issues force additional cuts. However, there are some positives. Some good rigs are being lost with the bad, and rail costs are forcing declines in high quality Bakken counties.
And here is the drill down, as well as his five key concerns abou why the market is misinterpreting the rig data, and why "small crude oil rallies can occur, but are likely limited and unsustainable."
A deeper look at oil rig count changes paints a different picture.
The US oil rig count has fallen from a peak of 1,609 for the week of Oct 10, 2014 to 1,223 last week. This drop of 386 rigs (24%) coupled with a 94 rig (7%) WoW decline created excitement among some bulls that a turn would come sooner. However, the experience in natural gas from 2011-14 should give investors pause about a falling oil rig count translating to significant production cuts. We don’t expect the same magnitude of efficiency gains, but mix shifts both within and across plays and rigs suggest activity will not slow nearly as much as headline counts suggest.
Five key concerns about rig counts and production.
1. Capex cuts come in waves, and the pace of drop may not be sustained. Many producers are implementing the first round of capex cuts for 2015, which can come quickly. Once plans are in place, there is a risk that the rig count decline may decelerate or stop until the next round of capex cuts are announced.
2. Thus far, lower performing vertical and directional rigs have been cut more than horizontal. Despite starting from a much smaller base, the vertical+directional rig count has fallen 202 (41%) vs. only 184 (16%) for horizontal oil rigs. In a more extreme example of this shift, the Permian horizontal oil rig count is equivalent to where it was when the US oil rig count peaked back in Oct (albeit it has decline marginally from its peak in Dec.
3. The average IP and production from vertical and directional rigs is much lower. In terms of contribution to oil production, the lower quality vertical rigs have initial production rates (IPs) that are just a fraction of horizontal wells. As an example, in the Permian Delaware, horizontal oil IPs can average nearly 500 b/d (with some counties much higher). In comparison, the average vertical and directional oil IPs are closer to 80 b/d. Hence, it may take 5-10 vertical or directional rigs to equal the production impact of a single horizontal rig.
4. Horizontal rigs fell more last week, but from low quality plays - consistent with the trend since Oct. Of the 94 rig decline last week, 66 came from horizontal rigs. While this is more helpful, the reality is that 46 of the decline came outside the three most prolific plays (the Bakken, Permian and Eagle Ford). In fact, of the 186 decline in horizontal oil rigs since Oct, 122 have come outside the Big 3 plays. Moreover, 33 of the 61 decline in the Big 3 since Oct has come from the Bakken where high rail costs are adding to the stress. The source of the decline is important because on average these other horizontal plays have ½ the IP rate of the Big 3, and often far less. Relative to the higher quality acreage in the Big 3 shale plays, other parts of the US can be as little as 10-25% of the average horizontal oil IP.
5. Even within plays, IPs can vary dramatically. Real analysis should be done at the county level given clear opportunities for high grading the portfolio within plays. Not every producers has the opportunity to shift from lower quality to the highest quality given geographic ownerships, which can create some noise in the data. However, when we look within plays, we see enormous gaps between the lowest and highest quality wells, as well as the average and top 25% of wells drilled. Within a play, the variance in IP rates across counties can be shockingly high, providing producers an opportunity to shift rigs in the portfolio. We have already seen evidence of this high grading occurring with rigs still increasing in some counties.
His conclusion: look at the Permian: "The Permian, which was a big focus in this week’s numbers, offers an example of many of the above issues. Much was made of the drop in the Permian rig count (25 rigs). However, 16 of the drop came from vertical and directional rigs. Moreover, among the horizontal rigs, there was clear evidence of a shift towards more productive counties, especially in the Midland. The best counties generally saw rig counts increase or had rigs shuffled around between acreage. In the Midland, all of the decline came in much less productive counties, while the best count (Midland) saw rigs increase."
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with oil heading back to $100 I just can't stop luagh at all of those people that went out and dropped 50k on SUVs becuase of lower oil prices..OOPS
Saw a HUMMER driving in front of me the other day -- first one I've seen in several months!
Obama hints that the oil price collapse was engineered in an NPR interview late last year.
"If you'll recall, their economy was already contracting and capital was fleeing even before oil collapsed. And part of our rationale in this process was that the only thing keeping that economy afloat was the price of oil." ~ Barry O'Bama
http://www.npr.org/2014/12/29/372485968/transcript-president-obamas-full...
Figure it out people
we can still see 5 dollar gas with 50 dollar a barrel oll think about it, think about whats coming then u understand
Ok, but Russia hasn't capitulated. Far from it. By this logic, they would allow Russia to get stronger which is the one thing they don't want right now.
The global supply/demand situation was never so out-of-balance as to cause this crash.
My guess is that the costs of this ill-fated policy is increasing to uncomfortable levels for all parties.
Rustbelt Zombies ?
Yep, only the foolish thought oil would be in $30's. No way. If it does then it will be a temporary spike down. Time to start nibbling on the Oil stocks. Then load em up once crude bottom confirmed ( test of the crude lows fail).
That is all. Subscriber fees will be 2 beers emailed to me.
There is no reality, only trends. Trends that every gambler on the planet hopes to front run, creating the bubble. No one gives a shit if we have lots or very little oil. They only care what the market thinks...right fucking now. Anyone with a brain knows that these low prices will hollow out any competitive features of the market, leaving only the strongest players, and we also know that prices will come back with a vengeance. But again, no one cares what happens six months, much less than six years from now. They are trading NOW and hope to take their winning home with them tonight.
Fucking reality....makes me laugh.
It's the victims of this shit that will the only ones facing reality. The people who are actually having to consume, who do not buy stocks or place bets in the market.
Everyone bitches about how our government treats us like sheep, and then they run out and hope to find some of their own to shear.
Society is us. Look in the mirror if you want to see what it is and where its going. Everyone placing a bet in this shit has that shit on their hands. It matters not if you are the John, the pimp or the whore. Its the participation that matters.
No beer...but I dropped a Coke on my keyboard so you should be feeling the love pretty soon....
There is really only one important fact to consider when it comes to oil in the U.S.. Specifically, the U.S. is still a net importer of oil consuming just over 18 million barrels per day. Yes, even with the recent "decreases in demand" America still consumes a fuckload.
that is all.
We do NOT consume that much oil a day. That number includes natural gas which has a production curve that has been nothing short of ASTRONOMICAL in the past year EVEN THOUGH natural gas prices totally collapsed.
Also you need to look at GASOLINE consumption...which has never recovered consumption wise from the collapse in 2008.
Not so with prices though!!!
Bwhahahahahahaha. "Supply and demand." Yeah, right.
I make $75 an hour sitting on my mother's laptop at home getting paid by Goldman Sachs to spread contradictory information on the internet
I think you meant 'laid'...
how polite....it feels quite differently.
please put tape over the laptop camera....
I tried sitting on my laptop, and all I got was a broken laptop.
if you sat in front of it you could at least get 90-95 per hour....
It is always good to be horizontal.
Even when you are occupying a coffin and no longer breathing?
maybe this is about the saudis paying for those good citizen handouts and bonuses; while america was preparing for the superbowl friday saudis took advantage
Tyler, that headline tells the algos it's not as rigged as before. Stop it.
Algo's will never use ZH as its input of keywords.
A response to the article:
http://www.investorvillage.com/smbd.asp?mb=4288&mn=164938&pt=msg&mid=146...
stateside
The oil markets prepare for 6 to 12 months in the future, not the now
Just tell me if we will see UCO at $5 or less.
not if they reverse split :)
Crude up 5%-7% in ONE DAY.
This isn't a market, it's a CIRCUS.
Oilies and oil service stocks rising (or falling) based NOT on any fundamentals -- stocks like TransOcean up big -- yet deep water drilling is not going to go anywhere at $53. Oil and oilie stocks are being driven by the 'most shorted' mantra -- just like the the rest of the market has been for the past year. I'm scannng for babies with the bath water here, but I'm not buying anything up 15% in a week!
No less than the Hedge was saying short this stuff!
This place is a mo-mo monkey paradise.
FREE JON CORZINE!
Meh. Momentary ramp so that the TBTF's can unwind their positions, then they let go of the rope and it falls like a lead balloon again. Muppet bait.
Or Soverigns that rely on the oil revenue doing their part to drive prices higher. Lots of oil producing countries have lots of cash to manipulate the crude pricing. Wondering just how many contracts and options have been bought by Russia, Saudia, Qatar, UAE, England .............. doing their version of "Momentum Ignition". Competing with the algos or at least imitating them.
It is in their best interest. As their budgets depend on it.
Ok, I am an economic and financial nitwit, but I can 't keep wondering about this whole oil story. So is it oversupply ? To low demand ? Dunno, the world economy is in freeze since 2008. And the shale story is also up already much longer than last summer. But what I do known is : the oil is depleting, at a pace relative to demand, but it is depleting and fast. So this drop in price can be nothing but a political decision, that will not stand for long. Because no political decision ever has stood against mother earth. So going on a Frenzy buying SUV 's and real tanks does not seem a very good idea.
It takes two years to birth an oil well....if all goes well..no pun entended....right now wells are finishing up that will produce in the next few months....added supply...these wells that are pulling back would have shown up in two years from now as production...so we have a way to go to get supply and demand back in order..but if car sales keep going up 20-30% a month..that could do it....nothing like a 10 year loan on a car that will last 5 years...
I say again..."how does price at the retail level move that much that quickly Mr. Government guy?"
I would like to think he would want to know actually....
Its because the markets are controlled by paper now....it used to be just the users who bought futures..now everyone has a fast computer to play the paper options game....and when a wave starts....all the surfers jump on..and it makes the waves bigger and more destructive...and much faster...
Two years? More like two months. Or two days for the super shallow vertical guys.
Although the rig count is interesting, the market has been responding to the refinery workers strike as that has a direct effect on supply.
http://news.yahoo.com/strike-u-refinery-workers-extends-second-day-00010...
The rig count is mostly irrelevant until it actually starts effecting production, even then the inventory, which is still rising, needs to start falling, then the markets will notice.
the strike at the refinery level is bearish for the supply glut of unrefined oil
how can this strike be spun as anything but?
less oil refined means that less oil is sucked off the supply glut and supplies are swelling
profit taking is going to commence in 3,2,1...
the fundamentals still suck and this is way too juicy, way too fast
It was obvious they'd drill out the sweet spots at low prices.
But I wonder what Morgan Stanley's position is on oil?
This guy couldn't be talking his own book could he?
I knew an oil workers strike would raise oil prices because, uh...
This article reads as Common Sense 101. Of course you refocus resources to maximize cash flow and asset productivity as things tighten What this really is about is a desperate play by the operators of the financial asset ponzi to suppress the value of real assets and real options. And the Tylers are doing GS's work for it right now by focusing on very short term. Tylers, what is the average well depletion rate in traditional? In shale? What is current production of each? What is the alleged excess production/glut? This will all be done forever in 18 months...
There is another small point to maybe add : when a well is drilled, is not going to disappear just becasue its overindebted owner, and who invested in / financed it, defaults.
If the drilling cost is, let's say 100, the acquisition cost for the next well owner out of the bankruptcy may be a fraction of 100.
This means also that the new owner will have way lower acquisition costs to amortize, because someone else, the initial investor, has financed the delta.
If breakeven was initially 100, it could now become 60.
The real risk overtime may come from the present cuts in investment & development expenses, wich will create lack of capacity over time.
I don't know now is the bottom will be now, or tomorrw at USD 25 or 20 /bbl. For sure today is only, we will easily see down the road USD 100 - 150 / bbl again, if not higher.